This is the easiest way to pay less in taxes

There’s no better time than tax time to resolve to max out your 401(k)

Do you think discussions of 401(k) investing are boring? Maybe it’s time to think again.

With pensions a rarity these days, even for government workers, you need to do whatever you can to maximize contributions to a 401(k), or similar, tax-deferred retirement plan. If you’re self-employed, an individual retirement account, or IRA, is the way to go, and there are different types to consider, depending on your tax situation.

Some people believe the notion of “retirement” is silly, as today’s work culture suggests you should work until you die. Fine. But you can never be sure what the future holds, and even if your health holds up, you may have to stop working to take care of a spouse or another family member.

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Many employers offer 401(k) plans, with the employer matching an employee’s annual contribution up to a certain amount. For example, if your employer has a 3% match, that means you put 3% of your salary into the plan, and the employer pays the same amount on your behalf. So, in this instance, you’re looking at a 100% return during the first year. And your investment is tax-deferred, meaning it’s deducted from your income, lowering your tax bill. Meanwhile, there are no taxes on gains or dividends within your 401(k), and you will pay no taxes until you begin making withdrawals when you retire.

So it’s an easy decision to invest as much as your employer is willing to match. But you must go further.

Unless you’re wealthy or await a fat pension, you face a rude awakening in retirement — along with millions of other Americans. Sure, you may get Social Security, but the average payout is a little more than $1,000 a month. You may think you can’t afford to invest much in a 401(k), given mortgage payments and college bills, but you need to consider your entire financial picture when making the decision.

Get real about your retirement health-care costs

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Some people focus on what they want right now, such as a home with a “showroom” living room that is beautifully decorated but completely useless, while neglecting to get their financial house in order.

What does it actually mean to be able to afford something? A sales person might try to convince you that you can afford something if you can swing the monthly payments. But you can only truly afford those extras if you have enough left over after maxing out your retirement plan.

The annual IRS limit on contributions is $17,500. For people aged 50 or older, additional “catch-up” contributions of $5,500 are allowed, for a total of $23,000 a year.

Those are large, maybe even scary, amounts, so consider them your ultimate goal. Build up to the maximum by increasing your contribution election by 1 or 2 percentage points a year. If you are 40 years old, for example, and put in $17,500 a year until age 50, and then set aside the full $23,000 from 50 until 65, you will have invested $543,000, excluding your employer’s matching contribution.

You may be thinking: That’s not enough. But we can hope for solid stock-market returns over the long life of a maxed-out 401(k) plan. But if you were retiring today with a million dollars, the dividend income from that nest egg might be less than you expect. We’re still in a period of historically low interest rates, and depending on how much risk you could tolerate in an income investment portfolio, a 5% dividend yield would be relatively good. That’s $50,000 in income per year, which might not cut it 25 years from now, for 40-year-old sample investor.

A key point is to never give up. Regardless of your age or circumstances, you really have no choice but to do everything you can to maximize your retirement-account contributions.

The tax advantages

If you steadily increase your 401(k) contribution from year to year, you may well find your total tax bill decline in some years, even if you get a raise. That’s an awesome feeling when preparing your taxes.

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